Transfer of Wealth and Valuation

Greater Transfer of Wealth and Alternative Valuation Dates

The COVID-19 pandemic has created much uncertainty related to the future cash flow of businesses, their ability to pay debt obligations, and even their survival.  However, from another perspective, this turmoil has led to the decrease in value of many publicly traded equities and in turn opened the door for the possibility for business owners and individuals to transfer more wealth than before.

If you are a business owner in a privately-held company and were contemplating transferring wealth to the next generation, now may be the right time to do so.

Gift Tax

In 2020, the lifetime gift tax exemption increased to $11.58 million.  This means that over the course of an individual’s lifetime, they can gift $11.58 million without ever having to pay tax.  For married individuals, both spouses are entitled to the $11.58 million exemption.

For operating businesses, if due to the current uncertainty the future cash flow projections from operations are lower than historical results, valuation models would arrive at lower values than previous calculations.  In addition, due to the higher overall economic risk and uncertainty, increases in risk adjusted capitalization rates may be appropriate, which would also decrease the current value of the business.

If a majority of an entity’s assets are in real estate or marketable securities, the value of the assets may have decreased significantly due to the pandemic.   For example, as of December 31, 2019, for a company of which its sole asset is marketable securities worth $100,000,000, with no corresponding liabilities, an individual could transfer an 11.58% equity interest without triggering a taxable event.  However, if as of April 1, 2020, the value of the marketable securities decreased to $70,000,000, an individual could transfer a 16.5% equity interest without triggering a taxable event, an approximate 5% increase.

Estate Tax

IRC 26 U.S. Code § 2032 states, “…if the executor so elects… in the case of property not distributed, sold, exchanged, or otherwise disposed of, within 6 months after the decedent’s death such property shall be valued as of the date six months after the decedent’s death.”  In the unfortunate event that an individual passed away in the six months prior to the pandemic, an executor should consider electing to value the estate’s assets as of the alternative election date.  If the assets of a business decreased, or the future cash flow of a business is uncertain, use of the alternate election date could result in a lower estate tax burden.

The examples herein do not consider the effects of discounting the equity interest for lack of marketability and/or control.  The transfer of interests must be completed at fair market value with a supported business valuation.  Under the fair market value standard, discounts for the lack of marketability and/or control are often applied to the value of minority and/or non-controlling equity interests.

The discount for lack of control is typically supported by price to net asset value discounts in publicly traded closed-end funds.  The publicly traded closed-end funds are currently trading at a higher discount than experienced in late 2019.

A factor in the discount for lack of marketability is the time horizon with which privately-held businesses take to sell.  The merger & acquisition market is questionable right now as to what deals are being done and how they are financed.  Financial institutions are very back logged with Small Business Administration (SBA) loans as a result of the CARES Act and other government programs.

Should you have any questions with regards to a transfer of wealth and/or business valuations, feel free to reach out to Sax’s Valuation, Forensic and Litigation Department.

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